In Case You Think Gridlock in D.C. Is a Good Thing...

As if investors didn't have enough to be concerned about, add this: gridlock in Washington.

No, we're not talking about the weekend blizzard that's keeping the Capital area closed for a couple of days. We're talking about political gridlock, in which divided government -- Democratic control of the White House and, in this case, lack of ironclad control of the Senate -- prevents progress on key legislation, including the federal budget, banking regulation overhaul, energy policy, health care reform and others issues important to the financial markets.Of course, the event that could prove to be the stalled car that leads to the jam is the stunning victory by Republican Scott Brown in January's Massachusetts election to fill the Senate seat vacated by the passing of Democratic giant Edward M. Kennedy.

"Republicans Now Hold a 41-59 Majority in the Senate"

As most investors know, even though the Democrats still have more members in the Senate, Brown's victory gives the Republicans a 41st vote in that chamber, or enough to filibuster legislation, i.e. engage in an endless debate of key legislation so that no bill -- certainly no controversial legislation -- is passed. Or, as the joke goes these days inside the beltway, "The Republicans now hold a 41-59 majority in the Senate."

Indeed, if the initial political volleys are any indicator, the current climate doesn't look good for cooperation between the parties on the biggest problems facing the nation.

For example, despite public outrage at bonuses for executives of bailed out banks and at the perverse incentives that contributed to the financial crisis, so far not one Senate Republican has publicly stated that he/she favors a tax that discourages excessive pay at bailed-out firms or that realigns executive compensation with long-term shareholder interest. Hence, a Senate filibuster could result in the defeat of such efforts and the Obama administration's proposal to limit bank risk-taking.

Searching for Shared Sacrifice and Solutions

On health care insurance, with the original reform bill stalled due to lack of an agreement on funding between House/Senate Democrats, there's hope that President Obama's invitation to Republicans to attend a health care summit will lead to viable, shared-sacrifice solutions that have enough bipartisan support to pass both chambers.

However, the summit could amount to yet another session when the parties talked past one another. Or even worse, Republicans could turn the tables on Obama and use the White House's bully pulpit -- the summit will probably be televised -- to simply recite talking points and attempt to continue to portray Obama as "out of touch" with the majority of Americans.

Finally, and most significantly for investors, is the Obama administration's proposed, $3.8 trillion fiscal 2011 budget. An election year and Congress's desire to get work done quickly to allow ample time to get home to their districts to campaign suggest that both parties will agree on a budget for the next fiscal year in a normal time frame, by August. But Republicans, concerned that Obama's proposed budget -- which contains a projected a $1.6 trillion deficit -- spends too much, could seek changes that Obama and other Democrats oppose -- leading to gridlock, and no budget resolution.

A lack of a budget agreement would undoubtedly roil the financial markets. And if the parties don't come up with on a continuing resolution -- basically a measure that says "we'll use this year's budget outline until we approve the new budget," there's a chance the U.S. government will be shut down.
A Replay of 1995?

Think it can't happen? Think again. In 1995, when Republicans held a majority in Congress, led by Speaker Newt Gingrich (R-Ga.), they couldn't agree with Democratic President Bill Clinton on a budget, the GOP refused to pass a second continuing resolution.

Instead, Gingrich shut down the federal government, suspending nonessential services. The gamble backfired, however, with an irate public blaming primarily the Republicans for the stalemate. The fiasco was one factor -- along with a strong U.S. economy -- in President Clinton's reelection in November 1996.

Clearly, with credit markets still in the process of healing, and with the U.S. and global economies just beginning to pull out of a wretched recession, the economic and financial stakes are considerably higher now than they were in 1995. While no can predict the market's response with certainty, it's safe to say any interruption in the U.S. Treasury's authority to borrow money to pay for government operations would not be viewed favorably by the financial markets.

The Fault, Dear Brutus...

Moreover, while Americans can justifiably point a finger at both parties for any gridlock and failure to achieve bipartisan solutions to the nation's problems, part of the problem rests with the American people themselves.

That's because voters, once again, appear to be applying the U.S. Constitution's separation of powers doctrine (co-equal executive and legislative branches of government) to the political parties, as well. Distrustful of both parties, voters seem to think they can "balance them out," or "check their vices" by putting one party in control of one branch, and the other party in control of the other. That way, the parties can keep an eye on each other.

In theory, it can work out that way. But what Americans overlook is that for two-party governance to succeed, there must be mutual compromise and shared sacrifice. Without that, the result is divided government. And gridlock.

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Financial Editor Joseph Lazzaro is writing a book on the U.S. presidency and the U.S. economy.